Cliffs International Inc. v. Federal Commissioner of Taxation.

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Brinsden J.: This matter involves the consolidated hearing of three appeals by the taxpayer, Cliffs International Inc. from the disallowance of objections to income tax assessments made by the respondent Commissioner in respect of the financial year ending 31st December 1973 and the financial year ending 31st December 1974. Two of the appeals, Nos. 177 and 196 of 1976 relate to assessments of income tax of the taxpayer in respect of the financial year ended 31st December 1973 and the other appeal, No. 178 of 1976 relates to the assessment of income tax for the year ended 31st December 1974.

Principal Parties Referred to in These Reasons

Cliffs International Inc. - a U.S.A. Corporation incorporated in Cleveland, the United States of America and registered as a foreign company in Western Australia, the taxpayer (and hereinafter called ``Cliffs'') a wholly owned subsidiary of the party next mentioned.

Cliffs Western Australia Mining Co. Pty. Ltd. - a company incorporated under the Companies Act of the State of Western Australia and having its registered office at all material times at Perth in the said State and being at all material times a subsidiary of Cleveland Cliffs (``Cliffs Western'').

Basic Materials Pty. Limited - a company duly incorporated under the Companies Act 1961 of Western Australia (``Basic'').

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Howe Sound Company - a corporation incorporated in the State of Delaware, U.S.A. but during the time interval with which these proceedings are concerned, changed its name to Howmet Corporation (``Howmet'').

Garrick Agnew Pty. Ltd. - a company incorporated in Western Australia (``Agnew Co.'').

Mt. Enid Iron Co. Pty. Ltd. - a company incorporated in the State of Western Australia in accordance with the provisions of the said Companies Act (``Mt. Enid'').

Dampier Mining Co. Ltd. - a company incorporated in the State of Western Australia in accordance with the said Act (``Dampier'').

Mitsui Iron Ore Development Pty. Ltd. - a company incorporated in the said State pursuant to the said Act (``Mitsui'').

Robe River Ltd. - a company incorporated in the A.C.T. (``Robe River'').

THE 1973 AND 1974 ASSESSMENTS AND OBJECTIONS THERETO

Cliffs, having carried on business during the financial year 31st December 1973 in Western Australia and having earned income therefrom, returned its taxable income at a total of $1,072,084.00. The Commissioner on 24th April 1975 issued an assessment of income tax based on a taxable income of $2,276,924. Particulars of the adjustment to the taxable income as returned by Cliffs which are still in issue between the parties to these appeals, are as follows:

Cliffs objected to the assessment in respect of the above items and others which are now not material, and the disallowance of that objection comprises Appeal No. 176 of 1976.

Subsequently, and in respect of the same financial year, a notice of amended assessment dated 10th September 1975 was issued by the Commissioner, amending the taxable income to $2,372,016. The addition to the taxable income which is now in issue between the parties comprised interest received from Mt. Enid of $98,519. Cliffs objected to the notice of amended assessment and the disallowance of that objection resulted in Appeal No. 196 of 1976.

For the year ended 31st December 1974, Cliffs returned taxable income at $1,746,596. By notice of assessment dated 15th March 1976, the Commissioner issued an assessment of income tax based on a taxable income of $3,142,293. The additions to the taxable income which are now in issue between the parties are as follows:

Cliffs objected to that assessment and the disallowance of that objection results in Appeal No. 178 of 1976.

The parties agreed a statement of issues for my determination. Hereunder are those agreed issues.

1973 YEAR

1. ``Deferred payments'' - (referred to as royalties above and in the notice of assessment issued by the Commissioner).

Was the expenditure

(a) incurred in gaining or producing Cliffs assessable income;

(b) necessarily incurred in carrying on a business for the purpose of gaining or producing Cliffs assessable income;

(c) an outgoing of capital or of a capital nature.

2. ``Exchange losses'' - these losses are deductible if the deferred payments are deductible; that is, my decision in this regard is consequential on my decision in relation to deferred payments.

3. ``Unrecouped losses'' - an amount of $176,120 is deductible if the deferred payments are deductible; that is, my decision in this regard is consequential on my decision in relation to deferred payments.

4. ``Interest received from Mt. Enid'' - it is agreed that the derivation of this interest by Cliffs did not constitute the carrying on of a new separate business. The question is whether this interest was derived in carrying on by Cliffs of its normal business. If so, the interest is assessable under the general provisions of the Act. If not, the interest must be excised from the assessment as it falls outside the provisions of sec. 128B(3)(h)(ii)

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and is liable to interest withholding tax which has already been paid.

5. ``Credit for interest withholding tax already paid'' - if the interest received from Mt. Enid is assessable to Cliffs under the general provisions of the Act, the Commissioner will allow Cliffs a credit under sec. 221YS for the interest withholding tax already paid on this income.

6. ``Deduction for interest paid to Cleveland Cliffs in 1972'' - it is agreed that if the interest received from Mt. Enid is assessable under the general provisions of the Act, a deduction is allowable in 1972 for the interest which was paid to Cleveland Cliffs in 1972.

1974 YEAR

1. ``Deferred payments'' - the issues which arise in respect of this item are identical to the issues that arise in respect of the same item for the 1973 year.

2. ``Interest received from Mount Enid'' the issues that arise in respect of this item are the same as the issues that arise in respect of the 1973 year.

3. ``Legal expenses'' - one reason why the Commissioner disallowed these expenses was on the basis that Cliffs incurred the expenditure in seeking advice on matters having a connection with the deferred payments. The Commissioner's contention is that if these deferred payments are themselves not deductible for the reason that they do not fall within sec. 51(1), the legal expenses are also not deductible as they are of the same character as the deferred payments in respect of which the advice was sought.

If the deferred payments are held to be not necessarily incurred in carrying on Cliffs' business or of a capital nature, Cliffs contends that the legal expenses are nevertheless deductible on the grounds that the expenditure was not incurred on advice relating to the payment of the deferred payments but on advice relating to the retention of Australian tax from these payments, and that its expenditure

(a) was incurred in gaining or producing Cliffs assessable income; or

(b) was necessarily incurred in carrying on a business for the purpose of gaining or producing Cliffs assessable income; and

(c) was not capital or of a capital nature.

The Commissioner disputes this contention.

HISTORY PRIOR TO ISSUE OF ASSESSMENTS

It is now necessary to go into a history of events involving the principal parties set out in the legend above before I propose to deal with the issues raised by the assessments.

The history commences on 5th April, 1962 with a letter from the Under Secretary for Mines Western Australia, to Garrick Agnew on behalf of Basic that temporary reserves 2400H to 2417H for iron ore in the Hamersley Range of Western Australia, had been approved for a period of two years from 1st April 1962 to 31st March 1964. The reserves were subject to the attached conditions and covered an area of 246 square miles. That letter and the attached conditions were admitted in evidence as exhibit 1. The evidence discloses, and it was common ground, that occupancy rights to the temporary reserves were granted by that letter to Basic. The land was reserved pursuant to the provisions of sec. 276 and sec. 277 of the Mining Act 1904. In Nicholas v. State of Western Australia a decision by Hale J. unreported, his Honour held that those sections constitute a code relating to temporary reserves thereby dealt with, to the exclusion of any rights which might otherwise be acquired under the provisions of that Act. That case reached the Full Court ((1972) W.A.R. 168) where Jackson C.J. expressly agreed with that view and neither of the other members of the Court expressed dissent. The provisions of sec. 276 so far as material, enable the Minister to reserve temporarily any Crown land from occupation, that is from occupation pursuant to the other provisions of the Mining Act, but such reservation must be confirmed by the Governor within 12 months and if not so confirmed, then the land ceases to be reserved. The Minister may, again with the approval of the Governor, authorise any person to temporarily occupy any such reserve on such terms as he may think fit but subject to the provisions of sec. 277. The provisions of that section so far as material, provide that a right of occupancy may be granted for a period in excess of one year but, in that event, the Minister shall cause the terms and conditions relating thereto to be laid on the table of each House of Parliament within 14 days of the granting. Further, a right of occupancy

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granted for any fixed period may be renewed from time to time for any term not exceeding 12 months on each occasion of renewal, but if any such renewal is granted then the Minister shall cause the terms and conditions relating thereto to be laid on the table of each House of Parliament within 14 days of the granting of the renewal.

The conditions applicable to the right of occupancy of each temporary reserve granted to Basic so far as are material, provided as follows:

a. That the occupant shall not use the land comprised in the reserve for any other purpose than that of prospecting for iron ore.

b. That the occupant should commence such prospecting operations forthwith and should continue the same to the satisfaction of the Minister for Mines.

c. No transfer of the authority to occupy would be permitted without the approval of the Minister for Mines first obtained.

d. That the Minister may cancel the right of occupancy upon being satisfied that the whole or any of the conditions for the time being operative are not being or have not been fulfilled.

e. That the occupant of the reserve should furnish the Minister with a quarterly summary report applicable to operations being carried on within the reserve.

f. That at the end of each calendar year or upon surrender, expiry, cancellation or abandonment the occupier should furnish the Minister with a complete report of all operations carried out on the ground reserved, including information specifically listed relating to the exploration work engaged upon by the occupant in its search for iron ore.

g. That when it is shown to the satisfaction of the Minister that iron ore has been discovered on the reserves in payable quantities, the Minister, after negotiating with the occupant regarding the mining, treatment, processing and marketing of the ore (including conditions as to royalties, quantities, volume, rates, location and methods), will (subject to the provisions of any contract which the Minister may require the occupant to make with the State Government) offer to grant to the occupant for the mining of iron ore, mining tenements under the Mining Act 1904 and the regulations thereunder on such conditions as the Minister determines and on acceptance, will (subject to the Act and regulations) make such grants accordingly. If the occupant rejects, or within a reasonable time but not exceeding 90 days, fails to accept the offer, the Minister may make any similar grants on the same or less favourable conditions to any other or others, but will not, for a period of at least 2 years after the original offer is made, grant to any other or others for the mining of iron ore from the reserves any similar mining tenement on more favourable conditions without first giving to the occupant the right and opportunity to accept such grant upon those more favourable conditions.

h. It is to be understood that in imposing such conditions there is not necessarily any implied commitment that export will be permitted by the State, but this will be the subject of negotiation at the time, additional to, and independent of, any policy laid down by the Commonwealth Government regarding export.

i. Since it is the policy of the West Australian government to encourage and foster local industry, special consideration will be given in regard to conditions where local processing is proposed to the ore recovered.

In summary, it can be said that the rights of occupancy gave Basic the exclusive right to prospect for iron ore and the further right when it was shown to the satisfaction of the Minister that iron ore had been discovered on the reserves in payable quantities, to negotiate with him on behalf of the State of Western Australia, for a mining tenement to be granted under the Mining Act to mine the iron ore. During the creation of the temporary reserve no other person but the occupant was entitled to explore the land for iron ore though one of the conditions purported to provide that the authority should be no bar to any person desiring to require mining tenements for any mineral other than iron ore in the said reserves (but it must be open to doubt that any other person could acquire any type of mining tenement so long as the land was reserved from occupation under the Mining Act). It must be appreciated however, that the right of occupancy did not give Basic any right to any

77 ATC 4222

iron ore discovered upon the reserves. The only way Basic could become the owner of the iron ore or obtain the right to mine it, was after successful negotiations with the Minister pursuant to the conditions referred to above, resulting in the issue to it of a mining tenement or tenements under the Mining Act. Notwithstanding these restrictions however, Basic by virtue of the right of occupancy, had a valuable interest created by statute for the protection of which a court could give an appropriate remedy. In Delhi International v. Olive (1973) W.A.R. 52, the plaintiff being the occupier of a temporary reserve under a right of occupancy created under sec. 276, sought various declarations designed to establish that the defendant could not acquire rights as against it in respect of certain mineral claims which he had pegged on the land the subject of the reserve. Speaking of the right of the plaintiff acquired through the grant of the right of occupancy, Hale J. at p. 54 said:

``The next question is whether the plaintiff is entitled to the sort of declarations and injunctions for which it asked. Apart from the effect of sec. 266 of the Mining Act, it is, I think, clear that the plaintiff was so entitled. The authority to occupy which it holds under sec. 276 constitutes a personal and valuable interest created by statute, for the protection of which the court can give any appropriate remedy: it is enough to refer to Tonkin v. Brand (1962) W.A.R. 2 and Anisminic Ltd. v. The Foreign Compensation Commission (1969) 1 All E.R. 208.''

Section 266 to which his Honour refers in the above quoted passage was held by his Honour not to prevent the granting of the relief sought.

Before passing on in this historical narrative, I should mention that Nicholas's case concerned certain temporary reserves known as the Angela reserves, which reserves are subsequently referred to in this narrative in another context.

At all relevant times Basic's shareholding was owned as to 49.9% by Agnew Co. and as to 50.1% by Howmet. In July 1962 Cleveland Cliffs was approached by Howmet about interesting itself in the temporary reserves. Mr. W.E. Dohnal was the only witness called in this case and was called on behalf of the appellant. He is presently managing director of Cliffs but has been associated with Cleveland Cliffs interest in Western Australia since its inception in 1962. He told me that Cleveland Cliffs has been a merchant producer of iron ore for some 125 years, has engaged in bulk transportation of iron ore on the Great Lakes in the United States and has acquired a world-wide reputation for its expertise in the development of technology as it relates to the beneficiating, upgrading, concentrating and pelletising and other forms of improving iron ore. Howmet produced a report upon the reserves compiled in August 1962. This report, though rather brief and not one which was sufficiently in depth to enable Cleveland Cliffs to make an evaluation of the potential of the reserves indicated that there were two types of deposits of iron ore in substantial quantities.

Cleveland Cliffs was sufficiently interested in the project to enter into an agreement (hereinafter called the Option agreement) dated 27th November 1962 between it, Howmet, the Agnew Co. and Mr. and Mrs. Agnew. It is this agreement which provides for the payment of the deferred payments or royalties mentioned above. It is apparent from a perusal of the agreement that it must have been prepared in the United States as the spelling indicates that origin. The agreement also indicates that the draftsman did not appreciate fully the limited rights granted to Basic by the rights of occupancy. It recites that Cleveland Cliffs is long experienced in the prospecting for and exploration and development of iron ore deposits, and in the mining and marketing of iron ore, and that Basic owns certain rights and certain iron ore deposits located in the Hamersley Range in Western Australia and that Howmet and the Agnew Co. together own all the stock in Basic. By art. 1, Howmet, the Agnew Co. and Mr. and Mrs. Agnew separately but not jointly, warrant certain things to Cleveland Cliffs, the material ones being that they own the entire equity interest in Basic free and clear of all liens, encumbrances and charges etc. and that they have full power and authority to sell assign and transfer the same to Cleveland Cliffs, but the Agnew Co. may, before the closing date thereinafter mentioned, transfer the shares to another company controlled by Mr. and Mrs. Agnew, and in such event the Agnew Co. and Mr. and Mrs. Agnew shall jointly and severally guarantee the performance of the agreement by such other company. They also represented that Basic

77 ATC 4223

held exclusive rights to occupy the reserves and that all the terms and conditions and provisions contained in the conditions had been fully complied with and performed and that they were not in default. They also represented that Basic had no debts, liabilities or obligations of any nature except as exhibited to the agreement and that if Basic incurred any other debts, liabilities or obligations between the date of the agreement and the closing date, they would take such steps as necessary to discharge such debts, liabilities or obligations prior to closing. Further that Basic then had no operating assets relating to any business or operation other than iron ore and would have at the closing date, no commitments or obligations of any sort with respect to any such other business or operation. By art. 2, Cleveland Cliffs undertook at its own expense to perform certain work and to make certain investigations during the term of the option at no expense to Howmet or the Agnew Company. In summarised form this required Cleveland Cliffs to explore, drill and sample and test metallurgically to prove tonnages and quality of the ore in the reserves and to prepare a report thereon; to perform metallurgical tests with iron ore shipments of at least 1,000 to 2,000 tons which shipments were to be shipped to prospective Japanese purchasers for testing in Japan; to make a preliminary survey of railroad routes and port requirements; a written market survey; to assemble all data pertinent to the operation of a mine on the reserve; to prepare a feasibility report to include data concerning the operation of a mine, the shipment of ore, and to make use of such feasibility report to the extent necessary to secure adequate mining rights from the Australian Government (sic). Cleveland Cliffs agreed also to make available to the other parties, such reports. By art. 3, Howmet, the Agnew Co. and Mr. and Mrs. Agnew agreed, so long as they were stockholders of Basic, to cause Basic to do all that it had to do pursuant to the conditions attached to the rights of occupancy to preserve the prospecting rights. They also agreed to assist Cleveland Cliffs to secure for Basic, iron ore development and mining rights in the reserves upon such terms and conditions as should be most appropriate for the full development thereof and satisfactory to Cleveland Cliffs. Article 3 went on to say that the provisions should be effective throughout the option period and thereafter if Cleveland Cliffs should exercise the option. By art. 4 Cleveland Cliffs was granted the option to purchase from Howmet and the Agnew Co., their entire stockholding for ``the purchase price set forth below, payable to them in proportion to their participation above set forth'', such exercise to be by written notice before 31st December 1963. The material parts of art. 5 which were much discussed during the course of these proceedings are set out hereunder:

``The purchase price referred to in Article 4 shall consist of an Initial Payment of $200,000 (U.S.) payable in good New York or Cleveland, Ohio funds by certified or official bank checks at the Closing of the purchase hereinabove referred to, plus Deferred Payments equal to 15 cents (U.S.) per ton of Iron Ore payable as in this Article 5 set forth.''

The Article then went on to provide for the purpose of calculation of the 15 cents per ton payments, what was to be understood by ``iron ore'' and a ``ton''. Iron ore was defined to mean ``iron bearing material mined and transported from the Reserves by or with the consent of Basic or its successor in interest, whether or not such iron ore shall have been dried, roasted, burned, sintered, crushed, ground, concentrated, pelletised, agglomerated or otherwise beneficiated or processed or prepared prior to sale or consumption.'' Within 90 days after June 30th and December 31st of each year Cleveland Cliffs was obliged to make or cause to be made to the other parties, report of the tons of iron ore mined and transported from the reserve during the semi-annual period then ended, together with payment by cheque drawn on good United States funds, of their respective participations in the deferred payments. The Article also provided that iron bearing material mined from the reserve should be considered as still located at the reserve so long as it is located at any plant in Australia for the purpose of drying, roasting, burning, sintering, crushing, grinding, concentrating, pelletising, agglomerating or otherwise beneficiating or processing or preparing prior to its sale or consumption.

Article 6 permitted Cleveland Cliffs by notice in writing delivered to the other parties at any time prior to the time for completing its purchase, to designate another corporation or

77 ATC 4224

similar organisation organised under the laws of Australia or one of the States of the United States to make the purchase provided for in art. 4. In such event and after such corporation has agreed in writing to be substituted for Cleveland Cliffs under the provisions of this agreement, such corporation should thereafter for all purposes of the agreement be substituted for Cleveland Cliffs as though it were an original party except that Cleveland Cliffs should remain liable to the other parties as guarantor under the agreement and of the obligation of such corporation to make the initial payment and the deferred payments as provided for in art. 5. There was also a provision excluding Cleveland Cliffs from this liability as guarantor in certain circumstances.

In respect of this agreement, it may be noted at this stage the following. This was no option agreement in which, for a small consideration, the offeror bound himself not to sell the property to anybody else, while the offeree decided whether or not to exercise the option, for in this case the offeree was obligated to undertake certain exploratory work as described in art. 2 and to prepare reports, which would have involved considerable expense, while the offerors bound themselves to assist the offeree in securing for Basic iron ore development and mining rights. Both the Agnew Co. and Cleveland Cliffs were entitled by the agreement to substitute for itself, another company and as it will shortly be seen this is what happened. The purchase price is described in the agreement as consisting of an initial payment of $200,000, plus deferred payments equal to 15 cents U.S. per ton of iron ore payable as set out in art. 5. The purchase was to be consummated at the offices of Messrs. Parker and Parker, Solicitors, Perth at the date specified in Cleveland Cliffs' notice of exercise of the option but not less than 20 nor more than 30 days from the date of such notice and which date was given the term ``Closing'' by making the initial payment against delivery of appropriate certificates and assignments. Consequently, upon payment of the initial payment, Cleveland Cliffs was in a position to transfer the shares formerly owned by Howmet and the Agnew Co. to itself or to its designated transferee, and thus acquire complete control of Basic, and through Basic, the rights of occupancy. The agreement does not obligate Cleveland Cliffs to mine, or cause to be mined, iron ore on the reserves should it exercise the option, hence the agreement by itself does not assure to Howmet or the Agnew Co., payment of any of the deferred payments. Those payments became payable only if and when iron ore was transported from the reserves, whether as the result of mining by Cleveland Cliffs or some other party.

Mr. Dohnal, whose evidence I found to be very fairly given, detailed the negotiations leading up to the option agreement. A number of cases were cited to me by counsel for Cliffs, justifying the reception of such evidence, namely Ralli Estates Ltd. v. Commrs. of I.T. (1961) 1 W.L.R. 329; I.R. Commrs. v. Church Commissioners for England, (1975) 1 W.L.R. 251 and the same case (1976) 3 W.L.R. 214 but in fact counsel for the Commissioner raised no objection to this evidence and in any event on those authorities I was entitled to receive such evidence. Earliest discussions involved Cleveland Cliffs coming into the deposits on a royalty free basis or at a minimum royalty, but those discussions led to nothing. The figure of $200,000 appears to have been arrived at as recompense for expenditure incurred by Howmet and the Agnew Co. in connection with the work they had already done in evaluating the deposit and for which they wished to be reimbursed. It also included a figure to cover a finder's fee, that is, a fee payable to the original finder. As to the figure of 15 cents per ton, it appears that it was arrived at after a series of discussions and negotiations as to comparative royalties etc. in the United States. It was simply a negotiated amount. There were various plans put forward based on percentage of profits that might be obtainable but none of those propositions interested Cleveland Cliffs because of the risks involved and because of the fact that it could not at the stage negotiations were being pursued, properly assess those risks, as very little was known of the extent of the deposits and their true value. As to the actual term used in the agreement, namely ``deferred payments'' that was not a term brought into the discussions until a very advanced date and was brought in then only at the suggestion of Howmet for purposes of its own. So far as Cleveland Cliffs was concerned, the 15 cents

77 ATC 4225

per ton payment had always been regarded by it as a royalty and it continued so to regard it whatever term Howmet wished it to be expressed by in the agreement. During the discussions, it was suggested to Cleveland Cliffs that if it exercised the option it should be obliged to mine the deposits but the company declined to agree.

It is convenient at this stage to point out that the authorities seem to suggest that whatever description the parties to an agreement may give to a payment, that description is not conclusive for the purpose of a revenue case. There are many such authorities to support that view, some of which are Vestey v. I.R. Commrs. (1962) 1 Ch. 861 per Cross J. at p. 874; Secretary of State in Council of India v. Scoble (1903) A.C. 299 at p. 302; and McCauley v. F.C. of T.(1944) 69 C.L.R. 235 per Rich J. at p. 245.

It should also be noted that the option agreement did not provide for the return of the shares to the vendors should Cleveland Cliffs or its nominee, not proceed with mining operations on the reserves. Notwithstanding that fact it seems to me clear enough from a reading of the agreement alone, that what Cleveland Cliffs sought by the exercise of the option was to gain control of the company to enable it to control and take advantage of the occupancy rights over the reserves in the hope that its investigation of the reserves would demonstrate the economic feasibility of mining the iron ore. This point is also made clear by Mr. Dohnal's evidence when he stated that the company was only interested in the rights of occupancy, bearing in mind that these could not be transferred by means other than with the approval of the State. It seems also clear that at the time the agreement was entered into, Cleveland Cliffs must have been of the opinion that there was potential in the reserves, for it was prepared to undertake considerable expense in fulfilling the obligations contained in art. 2 of the agreement. By the time the exercise date drew near, Cleveland Cliffs would have considerable additional knowledge of the potential of the reserves by reason of the work it was obliged to undertake, and by its exercise of the option, I have no doubt, that both it and the other parties to the option agreement believed that there was a reasonable chance that mining operations would be conducted upon the reserve but at that time it was not certain that such mining operations would take place.

On the same date as the option agreement was entered into, that is 27th November 1962, Cleveland Cliffs also entered into an agreement with the Agnew Co. This agreement in summary provided that in the event of Cleveland Cliffs exercising the option it would thereafter, with all convenient speed, form a company or companies (referred to as the operating company or companies) to mine, exploit and develop the reserves and to sell the ore obtained therefrom, and the Agnew Co. or any company or companies nominated by it should have the right to purchase, and Cleveland Cliffs undertook that the operating company would offer to the Agnew Co., 7½% of the capital then or at any time or times thereafter to be subscribed in the operating company, upon certain terms and conditions, provided however, that the Agnew Co. should have three years from the date any capital was to be subscribed to the operating company, to pay for the capital purchased by Agnew Co., and provided further that the Agnew Co.'s aggregate investment in the operating company should be limited to $2,500,000 (U.S.). This agreement later led to litigation between the parties, but that litigation after an appeal to the High Court, was ultimately compromised resulting in, among other things, a loan agreement between the successors to these companies, namely Cliffs and Mt. Enid, but to detail further the terms of this loan agreement is to anticipate events. I do not believe, however, that the agreement of 27th November between Cleveland Cliffs and the Agnew Co. (which I shall call for convenience the Agnew Agreement) requires Cleveland Cliffs to mine the iron ore reserves. It seems to fall short of that requirement, merely going so far as to require it to form an operating company. I therefore affirm my earlier statement that notwithstanding the exercise of the option, Cleveland Cliffs was not obliged to mine or cause to be mined the iron ore upon the reserves.

The option was exercised and completed on 17th January, 1964 and all shares in Basic were

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transferred to Cliffs and Mr. Dohnal on behalf of Cleveland Cliffs. Prior to the completion, Cleveland Cliffs designated Cliffs to make the purchase on its behalf and on 30th December 1963, Mt. Enid resolved to accept an offer made to it by the Agnew Co. for the sale to it of the Agnew Co.'s shares in Basic. Mt. Enid did purchase such shares and thereby acquired all the right title and interest of the Agnew Co. in the option agreement. On the 18th day of March, 1964 the shareholders of Basic met and resolved inter alia that the company acknowledged that the rights of occupancy were held in trust for Cliffs. The reason for this was stated by the minute of the meeting to be ``at the present time all the shares in the company are held by or on behalf of Cliffs International Inc. which at present is engaged in investigating the possibilities of mining the Rights of Occupancy held by the company of the iron ore deposits in the Robe River area. These investigations involve the expenditure of large sums of money''. Thereafter, if not before, Basic in respect of the rights of occupancy was a trustee for Cliffs.

The next step is the agreement between Basic and the State of Western Australia of 18th November 1964. That agreement is now a statute by virtue of the provisions of the Iron Ore (Cleveland Cliffs) Agreement Act No. 91 of 1964. That agreement acknowledges that Basic is a wholly owned subsidiary of Cliffs which in turn is a wholly owned subsidiary of Cleveland Cliffs. It is not necessary to go into this agreement in much detail, but in summary it can be said that it provides for the continuing exploration by Basic of the temporary reserves with a view to mining the reserves and during the continuance of the exploration, its rights of occupancy are confirmed up to 31st December 1965 and thereafter until application for a mineral lease or the termination of the agreement or the abandonment thereof. The company is obliged to submit proposals are accepted, a commencement date is declared, and thereafter the company becomes entitled to a mineral lease for 21 years under certain terms and conditions. The agreement also provides that the company shall pay the State a royalty on all iron ore from the mineral lease shipped or sold at certain rates. By cl. 13 the company may at any time dispose of to an associated company as of right and to any other company or person with a consent in writing of the Minister, the whole or any part of the rights of the company under the agreement or as the holder of any lease. An associated company is defined to mean a company of a specified amount of paid up capital incorporated in either the United Kingdom, the United States of America or the Commonwealth of Australia, and which is a subsidiary of the parent company or in the manner specified, is connected with the parent company. Parent company means and includes both Cliffs and Cleveland Cliffs.

On 21st October 1965, at an extraordinary general meeting of the shareholders of Basic it was resolved that the company be wound up voluntarily and that the liquidator be authorised to divide all or such part of the assets of the company as he shall think fit amongst the members of the company in specie. At that time the only assets of the company were the rights of occupancy which it already declared it held in trust for Cliffs and of course its interest in the agreement with the State of Western Australia. The next logical step was taken on the 19th November 1965 when an agreement was entered into between the State, Cliffs and Basic, whereby Cliffs undertook as from that date to be bound by the terms of the agreement with the State of the 18th November 1964, and Basic was released by the State from any further performance of its obligations under the agreement. At about the same time, 7th December 1965, Basic assigned to Cliffs all its interest in the agreement with the State and its rights of occupancy. From this point on Basic faded out of the picture.

From 1964 onwards, Cliffs continued to investigate the temporary reserves, and during the investigations it was discovered that the extent of the deposits was not as great as initially supposed. Consequently Cliffs looked around for additional deposits which could be mined in conjunction with the satisfactory deposits on the temporary reserves, and that enquiry led them to the Deep Dale deposits controlled by Dampier. An Agreement was entered into on 30th September 1969 between Dampier and Cliffs whereby, in effect Cliffs sub-leased the mineral lease Dampier had or

77 ATC 4227

was to obtain of the Deep Dale deposits, for the purpose of mining up to 150 million tons of ore, subject to payment to Dampier of royalty. Consequential amendments were made to the agreement with the State of 1964 which are embodied in the agreement annexed to Act No. 35 of 1970. In the interim Cliffs Western had been formed and Cliffs was involved in negotiating with other parties to form a joint venture agreement to mine the deposits. Ultimately it found the joint venturers as to Mitsui 30%, Robe River 35%, Mt. Enid 5% and Cliffs Western 30%. These parties entered into an agreement with Cliffs dated 25th May, 1970 which had the effect of transferring to them as tenants in common in the proportions of their respective individual shares, Cliffs interest in the State agreement and the Dampier agreement, but not the mineral lease which was to issue to Cliffs, subject to the joint venturers paying the royalties and rent to the State which Cliffs was obligated to pay under the State agreement, and also paying to Cliffs a royalty. That royalty is provided for in cl. 6(d) as on iron ore produced by or for the participants and sold or shipped for sale or commercial use from the areas the subject of the State and Dampier agreements at certain specified rates per ton of pellet and ore other than pellet. As the joint venturers over the last few years have in fact been mining the deposits, royalties have been received by Cliffs from the participants. Cliffs has paid to Howmet and Mt. Enid the deferred payments arising by reason of iron ore being mined and transported from the reserves at the rate of 15¢ U.S. per ton as provided for in the option agreement. It is these payments which for the years ending 31st December 1973 and 31st December 1974, Cliffs claims are allowable deductions by reason of the provisions of sec. 51(1) of the Income Tax Assessment Act 1936. Simultaneously with the agreement of the 25th May, 1970, the same parties entered into an agreement with the State which is embodied in the documents dated 29th June 1970.

Continuing the narrative forward, the principal Act the Iron Ore (Cleveland Cliffs) Agreement Act of 1964-70 which dealt with the original State agreement and the amendments thereto, provided for certain additional areas to be mined by the joint venturers. These additional areas are the Angela reserves which were the subject of the litigation in Nicholas v. The State of Western Australia previously referred to. The only part of that Act referred to by counsel for Cliffs is the provision in the lease which is a schedule to the agreement annexed to the Act, that Cliffs shall, if the Minister for Mines determines, pay to the previously registered occupant of the Angela reserves, an amount to recoup him for the expenditure incurred by him on exploration of the reserve, and during the term of the lease, a royalty at the rate of.25% per ton on the value of iron ore shipped or sold by Cliffs from the land formerly comprised in the reserves.

There are now two other matters which I should mention before this narrative is completed. I have already previously referred to the compromised litigation between the Agnew Co. and Cliffs concerning the Agnew Agreement. One of the terms of the compromise was that Cliffs should lend money to Mt. Enid. On 29th June 1970 Cliffs and Mt. Enid entered into an agreement of loan along with Mr. & Mrs. Agnew and the Agnew Co. By this agreement, Mt. Enid agreed to borrow from Cliffs and Cliffs agreed to extend credit to Mt. Enid by making loans at any time and from time to time from and after the date thereof, to and including the date of certification of the initial stage of the project (i.e. the joint ventured mining operation) in an aggregate principal amount not exceeding $2,500,000 to facilitate Mt. Enid's obligation to pay call sums under the joint venture agreement. The loans were to be repayable at the expiration of 5 years after the date of borrowing and were to bear interest. Moneys have been lent under this loan agreement and interest paid, and it is this interest which is the subject of the dispute between the parties in relation to both tax years. On 27th June 1970, the same company entered into another agreement which I shall call the Mt. Enid agreement. It recites the making of the Option agreement, the purchase price payable by Cleveland Cliffs if it exercised the option (which description refers both to the initial payment and the deferred payments) that it was recognised by the terms of the Option agreement that the Agnew Co. might, prior to the exercise of the option, transfer its shares in Basic to another company and that it had in fact done so by transferring the shares to Mt. Enid. It also recites that, by the Option agreement Cleveland Cliffs reserved the right to nominate another corporation to make the

77 ATC 4228

purchase, and that it had done so by nominating Cliffs. It then recites that Cliffs has agreed to enter into the agreement at the request of Mt. Enid to confirm its obligations in terms of the Option agreement so far as it relates to Mt. Enid and to more effectively secure all deferred payments from time to time due to Mt. Enid thereunder. By cl. 2 Cliffs acknowledges and confirms its liability to make the deferred payments from time to time payable in the terms of the Option agreement, and confirms so far as Mt. Enid is concerned, that it will make such deferred payments to it. Cliffs then proceeds to charge the royalties due to it from the participants with the payment of the deferred payments. It was argued by counsel for Cliffs that the deferred payments were now in fact made pursuant to the Mt. Enid agreement and not the Option agreement so far as Mt. Enid is concerned, and, he said, that there were minor and major differences between Cliffs' obligation under the first agreement with its obligations under the second agreement. I must say I am unable to see any significant variation between the obligations. It was pressed upon me that, under the Option agreement there was an obligation to make payments in respect of iron ore mined and transported from the reserves, whereas under the Mt. Enid agreement the obligation did not arise if the iron ore was located at any plant in Australia for the purpose of drying, roasting or other form of treatment because it was then said to be still located within the reserve. But that provision also appears in the Option agreement. Indeed, it seems to me that the Mt. Enid agreement has been careful to follow exactly the phraseology and obligations in respect of the payment of the deferred payments as provided for in the Option agreement. All that the Mt. Enid agreement seems to me to do is to make clear the recognition by Cliffs that Mt. Enid is now entitled to receive the deferred payments as the successor of the Agnew Co. and in addition provides a charge for the security of those payments. I therefore do not think that it can be said that the payments to Mt. Enid arise under the Mt. Enid agreement. The obligation to pay remains under the Option agreement.

I now propose to deal with the issues between the parties.

1. Deferred payments

It is perhaps best to begin this matter by considering whether the deferred payments are an outgoing of capital or of a capital nature. Should they be considered as an operating expense and on the revenue side as contended for by Cliffs or as a payment of a capital nature being a payment as part of the purchase price for what was sold by the Option agreement? There is no doubt that the Option agreement itself and indeed some of the other agreements which refer to the Option agreement treat the deferred payments as part of the purchase price. I have already referred to authority which indicates that, notwithstanding the terminology chosen by the parties to an agreement, that terminology is not necessarily a true description of that to which it relates. So the parties to an agreement cannot turn into a revenue expenditure that which is truly a capital expenditure by saying that it is such. However, I must start I think, from the point that the description ``purchase price'' having been accepted by Cliffs must be taken prima facie to be a correct description of the deferred payments (see Ralli Estates Ltd. v. Commrs. of I.T. at p. 334). I have already referred to the evidence of Mr. Dohnal, which I accept, that Cleveland Cliffs regarded the deferred payments as being in the nature of a royalty. It is also apparent from what was exhibited during the hearing that others also regarded the deferred payments as of the nature of royalty payments. For example, in an affidavit sworn by Mr. Agnew, presumably in relation to the litigation concerning the Agnew Agreement, he referred to the Option agreement as the ``royalty agreement''. Likewise, in a letter dated 4th January 1966, to Mr. Dohnal on behalf of the Agnew Co., Mr. Agnew again referred to the agreement as a royalty agreement. The tax advisers to Cliffs, Price Waterhouse & Co., in correspondence with the Commissioner, refer to the payments which Cliffs is liable to pay to Howmet, that they ``may constitute payments as or by way of royalties''. In the Robe River prospectus, reference is also made to royalties payable to Cliffs by the joint venturers and from those royalties, Cliffs is obliged to make payment of U.S. 15¢ per ton to Howmet and Mt. Enid. And finally, the Commissioner in correspondence has referred to these payments as a royalty. I do not for myself think a great deal is to be gained from this evidence, in the sense that it could not possibly, by itself cause me to reach the conclusion contended for by Cliffs. In a doubtful case, however, it may be of assistance in reaching a final determination.

77 ATC 4229

The difficulty of determining whether a payment or a receipt is of a capital or revenue nature has been commented on before. Indeed Sir Wilfrid Greene M.R. in I.R. Commrs. v. British Salmson Aero Engines Ltd. (1938) 2 K.B. 482 at p. 498, after referring to the fact that many cases fall on the border line, said that the spin of a coin could decide the matter almost as satisfactorily as an attempt to find reasons. The difficulties have also been referred to in Van den Berghs v. Clark(1935) A.C. 431 at pp. 438-441, while in B.P. Australia Ltd. v. F.C. of T.(1966) A.C. 224 at p. 264, the Privy Council said:

``The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a common sense appreciation of all guiding features which must provide the ultimate answer. Although the Categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. That answer:

`depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, procured employed or exhausted in the process.':

Further authority along similar lines is to be found in the words of Lord Reid in Strick v. Regent Oil Co. Ltd.(1966) A.C. 295 at p. 313 when he said that the ``question [which] must be answered in light of all the circumstances which it is reasonable to take into account, and the weight which must be given to a particular circumstance in a particular case must depend rather on common sense than on strict application of any single legal principle.''

Cliffs has treated in its own books of account, the deferred payments as an expense in the profit and loss accounts and it may be that that method of treatment is in accordance with the ordinary principles of commercial accounting, though no expert evidence was called to support that view. But even so, if the Income Tax Assessment Act prohibits a particular kind of deduction that prohibition must receive effect. Even though Cliffs treats the payments as being payments out of revenue, that does not necessarily make them outgoings of a revenue nature: see Williams A.C.J. Colonial Mutual Life Assurance Society Ltd. v. F.C. of T., (1953) 89 C.L.R. 428 at p. 447 and Lord Greene M.R. in Associated Portland Cement Manufacturers Ltd. v. I.R. Commrs., (1946) 1 All E.R. 68, at p. 70 and quoted by Fullagar J. in the C.M.L. case at p. 458. Though the way in which the payments have been treated in the company's books of account may be one test to determine whether the expenditure is of a capital or revenue nature, it is therefore not a conclusive test.

My enquiry is to ascertain the true nature or substance of the transaction embodied in the Option agreement. That the enquiry is to ascertain the true nature or substance of the particular transaction has been echoed in a number of cases, I.R. Commrs. v. Church Commissioners (1976) 3 W.L.R. 214 at pp. 224, 229, 300; Poole & Dight v. F.C. of T.70 ATC 4047 at pp. 4051-2; (1970) 122 C.L.R. 427 at pp. 435-6; Hallstroms Pty. Ltd. v. F.C. of T. at p. 647; Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. at p. 454; B.P. Australia Ltd. v. F.C. of T. (1964) 110 C.L.R. 387 at p. 417. As Fullagar J. put it in the C.M.L. case p. 454: ``The questions which commonly arise in this type of case are (1) what is the money really paid for and (2) is what it is really paid for in truth and in substance a capital asset.'' In this case, what Cliffs sought to acquire was in first instance, the shares in Basic. The reason behind that acquisition was to acquire the right to enjoy the occupancy rights of the temporary reserves and still further ahead of that, the right to negotiate with the State to acquire a mineral lease to mine the iron ore on the reserves should investigations prove the feasibility of such mining operations. Cliffs acquired the shares by the payment of $200,000 and those shares were to remain its property even if ultimately it determined not to mine or cause to be mined the iron ore on the reserves. So if the question of what the $200,000 was paid for is posed, the answer is clearly for the shares,

77 ATC 4230

and that payment was obviously to acquire a capital asset. But the payments to Howmet and Mt. Enid which have occurred since iron ore was mined and transported from the reserves are not paid for the acquisition of anything. They are paid because of a contractual undertaking to do so contained in the option agreement. The application of this test seems to indicate that the payments are not payments of a capital nature. It is best, I think, at this stage to distinguish Colonial Mutual Life Assurance Society Ltd.'s case which on the face of it supports the Commissioner's contention. The essence of the contractual relationship between the C.M.L. and Just brothers, I take from the judgment of Fullagar J. at pp. 450-1. It appears that the Just brothers agreed to transfer their land to the company in consideration of a promise by the company to pay to them for a period of 50 years from 1st January 1935 or from the completion of the building which ever was the later date, an amount equal to 90% of all rents as and when received from lessees or tenants of three shops and a basement to be erected in the new building. The whole essence and substance of the contract was that the company was to acquire the land of Just brothers in consideration of a series of payments extending over 50 years. There was no cash payment on the transfer of the asset to C.M.L. of a nature similar to the cash payment in this case on the transfer of the shares. Furthermore the Just brothers were ultimately to receive a finite sum equal to 90% of the rents over a period of 50 years. C.M.L. was obligated contractually to put up a building containing at least the three shops and a basement and to use its best endeavours to let the shops, so there really was no doubt that the Just brothers would receive the payments stipulated. The 15¢ deferred payments in this case may never have been paid at all as Cliffs was under no obligation to mine or cause to be mined the iron ore in the reserves and the payments do not cease after the expiration of a period of time or when they total some fixed sum. In my view in the C.M.L. case, it is clear that the payments constitute a price payable on the purchase of the land. On the other hand in this case I do not think it possible to say that the deferred payments constitute part of the price payable for the shares. Such a decision of course means that the description given to the deferred payments as part of the purchase price by the Option agreement is a misnomer. Certainly on this interpretation the deferred payments are part of the consideration for the transfer of the shares but as was pointed out by Rowlatt J. in Jones v. I.R. Commrs. (1920) 1 K.B. 711 at p. 714 ``there is no law of nature or any invariable principle that, because it can be said that a certain payment is consideration for the transfer of the property it must be looked upon as price in the character of principal. In each case regard must be had to what the sum is''.

I think the true nature of the transaction between the parties was this. Both parties had a reasonable optimism that ultimately the reserves would be mined. Cliffs was agreeable to expend a considerable sum of money to test up the reserves pending its decision to exercise the option, and if the option was exercised no doubt both parties would have an increased degree of optimism that a mine would result. The vendors were prepared to accept $200,000 to recompense them for their expenses incurred in the work they had done on the reserves in the hopeful expectancy that the reserves would be mined. All parties I think would have appreciated that no decision to mine would be taken by Cliffs unless it could mine at a profit and in reaching that conclusion it would have to take into account the 15¢ payable per ton of ore. Hence, I think the parties would have visualised the 15¢ being paid out of the proceeds of mining. Probably these payments to Howmet and Mt. Enid are in their hands of the nature of income receipts (certainly the Commissioner seems to think so in regard to Howmet but I was not told of his attitude to the payments to Mt. Enid) but because payments in the hands of the payee are correctly described as income receipts, it does not follow that so far as the payor is concerned those payments are on a revenue account, though often that must be the case: see Fullagar J. in Colonial Mutual Life Assurance Society Ltd. case at p. 453.

Applying some other tests, one seems also to reach the answer that the payments are of a revenue nature. If one considers whether the payments are made once and for all or recurring (in the latter case usually of a revenue nature) obviously these payments are recurring payments. That test is referred to in Hallstroms' case per Starke J. at p. 643 and per Dixon J. p. 646; B.P. Australia Ltd. v. F.C. of T. per Dixon J. at pp. 266-267 and

77 ATC 4231

Vallambrosa Rubber Co. Ltd. v. Farmer (1910) S.C. 519 at p. 525.

A further test is whether the expenditure was for the acquisition of the means of production to obtain income or in the use of those means of production, see Hallstroms' case per Dixon J. at p. 647 and Sun Newspapers Ltd. & Associated Newspapers Ltd. v. F.C. of T.(1938) 61 C.L.R. 337 per Dixon J. at pp. 359-360. In this case if the acquisition of the shares can be regarded as the acquisition of a profit yielding subject (and to do so is stretching credibility, because so much had to be done between the acquisition of the shares and the reduction of the temporary reserves into mine yielding profits), it seems to me that the deferred payments are more akin to payments made in the use of the profit yielding subject to gain income.

I now propose to look at some of the cases I have not as yet referred to or not referred to in detail, which were mentioned in argument and which might indicate that I should take the view that in this case the payments are of a capital nature. In Ralli's case the taxpayer received a right of occupancy to sisal estates for 99 years on the payment of a premium and a royalty on all sisal fibre exported up to a total of £174,600 but reducible in certain circumstances. This payment was described in the contract not as a royalty but as ``balance of the purchase money'' and was to be paid by monthly instalments assessed by reference to the tonnage of line sisal fibre produced and exported during the preceding months and was to be calculated on a sliding scale based on the average f.o.b. price of the line sisal fibre. The taxpayer claimed that the payment of £174,600 was an outgoing and expense wholly and exclusively incurred in the production of their income but the Privy Council concluded that that sum was part of the purchase moneys for a capital asset, and as capital expenditure, therefore, not deductible. Their Lordships had no difficulty in dismissing the appellant's contentions, finding significance in the fact that the payments were not over the whole of the 99 years' occupancy but only for an indeterminate period, probably only for a few years. Having rejected the contention that payments were a royalty, their Lordships then addressed their minds to the second contention that the payments were nevertheless of a revenue nature. They looked at the purpose of the payment noting that in the agreement the sum of £174,600 was calculated as part of the purchase price together with the premium, for the unexhausted improvements on the land including the lease, buildings, machinery and equipment. It was therefore part payment for the acquisition of capital assets. I think that recital of the facts clearly distinguishes that case from the present case. It is however instructive to note that their Lordships thought that the only way in which the payments amounting to £174,600 might be said to be income expenditure, would be if they were payments made in respect of the actual leaf potential on the estates at the time of the acquisition. The company would then be paying for the use of the property the subject of the lease as it used it, and so the payments would look as if they were a true royalty but the company was not in a position to put forward such an argument because of lack of evidence.

A case relied on by the Commissioner was the Minister of National Revenue v. Spooner (1953) A.C. 684. In that case the respondent sold all her right title and interest in the land which she owned in freehold to a company in consideration of a sum in cash, shares in the company, and an agreement to deliver to her 10% (described as a royalty) of oil produced from the land on which the company covenanted to carry out drilling and if oil was found, pumping operations. The company struck oil and paid to the respondent 10% of the gross proceeds of the oil which she accepted in discharge of the royalty. All the courts that dealt with the matter held that the sum so paid was not an annual profit or gain but a receipt of a capital nature. The distinction between this case and the present case is immediately apparent: Mrs. Spooner was entitled to 10% of the oil that is in specie; the case concerned a payment in the hands of the payee and not the payor; and so far as the company was concerned it was never in possession of the oil (at least so far as the contract was concerned) to which Mrs. Spooner was entitled.

I was also referred to in re the Income Tax Acts, (1915) 21 A.L.R. 359. The facts of that case are clearly distinguishable from the facts of the present case as there the balance of moneys payable from the gold won were clearly part of an overall finite purchase price. I was also referred to an American case,

77 ATC 4232

Nicholson v. Commr. of Internal Revenue, 3 Tax Court U.S. Reports, 596. Certainly the facts appear to be not dissimilar to the facts in this case but at the best it could be only a persuasive authority but there are so many apparent differences between the relevant legislation in the U.S.A. and in this country as to make the case of very little assistance.

Counsel for Cliffs stressed that the deferred payments are in the nature of royalty payments. Certainly there are features about them which are similar to the features of a royalty as understood and explained in McCauley v. F.C. of T. (1944) 69 C.L.R. 235 at pp. 243-4 and Stanton v. F.C. of T. (1955) 92 C.L.R. 630 at pp. 641-642. At no stage of course did Howmet or Mt. Enid have any interest in the lands upon which the iron ore was found, other than as shareholders of Basic which had rights of occupancy, and of course the Option agreement contemplated that they would not have even those rights by the time the deferred payments became payable, so it is not a case where the payments are made to the owner of the land for the use of the minerals in the land. However, I would not think that the meaning of the word royalty is closed. Indeed, the 1973 amendment to the State agreement to which I have already referred uses the word in circumstances where moneys are to be paid to the previous occupant of the Angelas reserves referred to in that Act, by way of a royalty, when that previous occupant no longer had, if he ever had, any right to ownership in the minerals or the land upon which they are to be found. But for the purposes of my decision I do not think it necessary to find that the payments are in the nature of a royalty. I content myself by finding that they are payments of an income nature and are therefore not covered by the exception in sec. 51(1) of the Income Tax Assessment Act as being losses or outgoings of capital, or of a capital nature.

In concerning myself firstly with an enquiry as to whether the deferred payments are losses or outgoings of capital or of a capital nature, it may be thought that the Commissioner accepted that otherwise those payments were incurred in gaining or producing the assessable income or were necessarily incurred in carrying on a business for the purpose of gaining or producing ``assessable income'' (see Dixon C.J. in John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1959) 101 C.L.R. 30 at p. 35). This however is not so, as the Commissioner strongly contended that, even if the exception did not apply, that is the deferred payments were not payments of a capital or of a capital nature, nevertheless they were not losses or outgoings amounting to allowable deductions. As I understood the Commissioner's argument, it was that the deferred payments were not relevant or incidental to the joint venture agreement by which Cliffs obtained its assessable income and that their payment was no part of carrying on a business for the purpose of gaining or producing assessable income.

In Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. at pp. 56-57, it was said by the Court:

``For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income, it must be incidental and relevant to that end. The words `incurred in gaining or producing assessable income' mean in the course of gaining or producing such income.''

Later it was said:

``In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income, or if none be produced, would be expected to produce assessable income.''

In this particular case, Cliffs' assessable income arises pursuant to the agreement between it and the joint venturers dated 25th May 1970 and in particular by cl. 6(d) thereof which provides for payment of a royalty on iron ore produced by or for the joint venturers, and sold or shipped for sale or commercial use from what is called the mineral lease area in the agreement, which area includes the temporary reserves referred to in the Option agreement, and further considering for this purpose that iron ore remains within the mineral lease area, if it is being transported for pelletising or other processing as iron ore or is being so pelletised or processed, until it is shipped from the vicinity of the processing plant by vessel or carrier and excluding ore shipped for testing purposes only. It is true that the condition precedent before the royalty becomes payable under this clause, namely that it be sold or shipped for sale or

77 ATC 4233

commercial use from the mineral lease area, is different from the condition precedent upon which the deferred payments under the Option agreement become payable, namely when iron ore is mined and transported from the reserves, with the theoretical possibility that Cliffs may become liable to pay the deferred payments on a particular consignment of iron ore before it becomes entitled to receive the royalty in respect of that same consignment. Nevertheless from a practical point of view it would seem the acts giving rise to Cliffs' entitlement to receive its royalty under the joint venture agreement necessarily create a liability in Cliffs to make the deferred payments. In my view the deferred payments as an outgoing are relevant and incidental to the gaining by Cliffs of its assessable income and are incurred in the course of gaining or producing that income. Consequently, I believe that the deferred payments are an outgoing under the first alternative posed in sec. 51. It may be recalled that under cl. 6 of the Joint Venture agreement the joint venturers agree to discharge Cliffs' liability to the State for rental and royalties payable by it under the State Agreements. Had Cliffs remained liable to pay the royalties and rental to the State as provided by the State Agreements, surely it could not be said that those payments were not outgoings incurred in gaining or producing its assessable income under cl. 6(d), and I can see no reason in principle why any distinction should be made between that case and the payment of the deferred payment. In my view the deferred payments are outgoings coming within the provisions of sec. 51 and are therefore allowable deductions.

2. Exchange losses

In view of my decision in relation to the deferred payments, these losses are deductible.

3. Losses carried forward

By reason of my decision in respect of the deferred payments, an amount of $176,120 is deductible.

4. Interest received from Mt. Enid

If the appellant is to succeed in this matter it must satisfy me that the interest received from Mt. Enid was not interest derived by it in carrying on business in Australia at or through a permanent establishment in Australia. It is not disputed that Cliffs has had at all material times a permanent establishment in Australia, nor is it disputed that it does carry on business in Australia. As I understand the appellant's argument, it is that the loan to Mt. Enid was an isolated transaction with no real connection with the business then being carried on by Cliffs at that time, which was the business of exploring, drilling and carrying out other operations until the stage had been reached whereby it was satisfied that an economic mining operation could be conducted. I have at some length narrated the history of Cliffs involvement with the Robe River deposits. It seems to me apparent from as early as 1962 that Cliffs ultimately hoped that it could develop or cause to be developed a mining operation on the reserves and at an early stage, namely 27th November 1962, it recognised that if a mining operation resulted from its activities, it would form an operating company and that that operating company would require capital to develop and/or operate the mining operation, and it agreed to cause that company to make available to the Agnew Co. or its successor, which turned out to be Mt. Enid, a share in the equity capital. From 1962 onwards, Cliffs indeed did carry out exploring, drilling and other operations upon and with reference to the reserves. It negotiated with the State and achieved an agreement with the State and later negotiated with Dampier and again with the State and achieved amendments to the State agreement. It also changed its initial concept of developing and operating a mine through an operating company to doing so by means of joint venturers, of which Mt. Enid was one. Obviously the joint venturers would need and indeed were required to furnish moneys towards development and establishment of the mine and working expenses. A dispute arose as I have already mentioned between Mt. Enid and Cliffs over the interpretation and execution of the provisions of the Agnew Agreement resulting in, the loan agreement between the parties. I agree with the Commissioner's contention that the loan agreement is inextricably bound up with Cliffs business activities as described above in Australia. While it is true that it is the only such loan agreement and that Cliffs is not in the money lending business, nevertheless, Cliffs was in the business of organising the development and working of a mine on the reserve and in part, in order to achieve or facilitate that object, the loan to Mt. Enid was made. For these reasons I am of the view that

77 ATC 4234

the interest falls within the provisions of sec. 128(b)(3)(h) so that the interest should be included in the assessable income of Cliffs.

5. Credit for interest withholding tax already paid

By reason of my decision in respect of 4, Cliffs is entitled to credit for withholding tax already paid in respect of the Mt. Enid income.

6. Deduction for interest paid to Cleveland Cliffs in 1972

A deduction is allowable in 1972 for the interest which was paid to Cleveland Cliffs in 1972, consequential upon my decision in relation to 4 above.

1974 YEAR

1. Deferred payments

The deferred payments are allowable deductions in respect of this tax year.

2. Interest received from Mt. Enid

Interest received from Mt. Enid was derived in the carrying on by Cliffs of its normal business and hence is assessable under the general provisions of the Act.

3. Legal expenses

The amount involved in this issue, $16,638, is the aggregate of fees incurred for professional advice to Cliffs concerning the retention of income tax from payments of the deferred payments to Howmet in the United States. It is claimed by Cliffs that the fees represent a loss or outgoing necessarily incurred in carrying on of its business for the purpose of gaining or producing assessable income and were not losses or outgoings of capital or of a capital nature. How the expenses were incurred can be seen from the exhibits. In compliance with the provisions of sec. 256 of the Act Cliffs sought advice from the Commissioner as to the amount if any, it should retain in respect of tax due by Howmet in respect of the deferred payments payable to it. The Commissioner by letter dated 11th June 1974 to Cliffs' tax advisers, stated that in his opinion the deferred payments constitute income liable to assessment of Australian income tax and that Cliffs was therefore required pursuant to the provisions of sec. 255 and 256 of the Act to retain from such payments an amount namely $228,352.45 in respect of income tax due by Howmet. On 23rd July 1974, the Commissioner by letter requested payment to it of that sum. By letter dated 27th September 1974, Cliffs wrote to Howmet giving details of the calculations relating to the deferred payments due for the period from 1st January 1974 to 30th June 1974 and remitted to it the total of those sums less an amount deducted by reason of the request of the Commissioner in respect of income tax payable by Howmet. Howmet promptly replied, stating that there was no legal justification for the retention of the money and demanding payment of the sum deducted and held by way of income tax. Further correspondence ensued, from which it became clear that Howmet was demanding payment of the deferred payments free of income tax deductions, and threatening to sue in America for the same. Cliffs sought legal advice, and advice from its tax advisers concerning the Commissioner's demand in relation to the income tax on the deferred payments, and Howmet's insistance on being paid in the United States, the full amount of the deferred payments. It is obvious that the dispute posed, and still poses for it is not yet resolved, a very difficult problem for Cliffs, as it may be liable to deduct the income tax which the Commissioner insists is payable by Howmet, but still be successfully sued in the United States, in which country Cliffs is incorporated, for the balance of the deferred payments represented by the income tax withheld in Australia. As Howmet and Cliffs are both United States corporations, an action could be brought in some court in the United States by Howmet against Cliffs to decide the issue between them, without any reference to/or intervention by an Australian court. The Option agreement provides by art. 9 that it shall be governed by and construed in accordance with the laws of the State of New York. If such legal action takes place, the American court may have to decide whether it will enforce the taxing Act of another country. In English law it seems clear that it is not the duty of an English Court to enforce the taxing Act of another country; see Indian and General Investment Trust Ltd. v. Borax Consolidated Ltd., (1902) 1 K.B. 539 at p. 550. There seems therefore no doubt and indeed it is not disputed by the Commissioner, that by reason of what has transpired, Cliffs bona fide incurred the expense to the extent to which it claims. I have of course held earlier that the deferred payments themselves are allowable deductions. It would seem to me therefore that it follows that advice sought and paid for by

77 ATC 4235

Cliffs concerning payment of income tax on behalf of Howmet by reason of the provisions of the Income Tax Assessment Act is an outgoing within the meaning of sec. 51. Indeed I did not understand the Commissioner to argue otherwise if I should find that the deferred payments were themselves allowable deductions. In my view therefore, the legal expenses are deductible.

Effect of Conclusions

For the financial year ended 31st December 1973

The taxable income of the taxpayer as finally determined by the Commissioner at $2,372,016 should be varied by deleting therefrom, the sum of $1,052,867 made up as follows:

Exchange losses $39,610
Royalties $837,137
Unrecouped losses $176,120

For the financial year ended 31st December 1974

The taxable income assessed by the Commissioner at $3,142,293 should be varied by deleting therefrom the sum of $1,193,278 made up as follows:

Royalties $1,176,640
Legal expenses $16,638

CREDITS

The taxpayer is entitled also to a credit against income tax assessed for the years ended 31st December 1973, and 31st December 1974, an amount equalling the withholding tax already paid on the interest received from Mt. Enid.

Finally, there is item 6 for the year ended 31st December 1973 to be considered. I did not appreciate the nature of this item during discussion, and if any order is required by me in connection with it as a result of my findings, I will be prepared to entertain argument as to the form of the order.

I believe therefore, the assessments of the Commissioner should be altered as indicated above and the credit referred to granted. I would, however, be prepared to entertain suggestions from counsel as to the form of order I should make in the light of these findings.

RESULT

1. Order that the matters be remitted to the Commissioner of Taxation to issue amended assessments to give effect to my reasons for judgment, as follows -

(a) For the financial year ended 31st December 1973 -

(i) The taxable income of the taxpayer as finally determined by the Commissioner at $2,372,016 should be varied by deleting therefrom, the sum of $1,052,867 made up as follows:

Exchange losses $39,610
Royalties $837,137
Unrecouped losses $176,120

(ii) The taxpayer is entitled to a credit against income tax assessed for this year of income, an amount of $11,286.20 equalling the withholding tax already paid on the interest received from Mt. Enid.

(b) For the financial year ended 31st December 1974 -

(i) The taxable income assessed by the Commissioner at $3,142,293 should be varied by deleting therefrom the sum of $1,193,278 made up as follows:

Royalties $1,176,640
Legal expenses $16,638

(ii) The taxpayer is entitled to a credit against income tax assessed for this year of income, an amount of $19,103.20 equalling the withholding tax already paid on the interest received from Mt. Enid.

2. Order that the Appellant's costs (including the cost of two Counsel for a four-day hearing, and recorded transcript) be taxed and when taxed be paid by the Commissioner of Taxation. Liberty to apply to both parties with respect to costs.